What is personal finance Specialized area of study that focuses on individual and household financial decisions Chapter 1 The Personal Financial Planning Process applying the planning process Goal setting Budgeting and spending Saving and investing Buying and leasing decisions Investing for the future Insurance Career and employee benefits decisions Components of a Comprehensive Financial Plan Protection Plan for death and incapacity Chapters 16 17 Build wealth Save and invest to meet short term and long term goals Chapters 11 15 Secure basic needs Liquidity consumer purchases and credit decisions insurance employee benefits Chapters 5 10 Establish a firm foundation Evaluate your finances acquire tools and skills set goals develop a budget Chapters 1 4 Components of a Comprehensive Financial Plan Establish a firm foundation Evaluate your finances acquire tools and skills set goals develop a budget Chapters 1 4 Secure basic needs Liquidity consumer purchases and credit decisions insurance employee benefits Chapters 5 10 Build wealth Save and invest to meet short term and long term goals Chapters 11 15 Protection Factors that Influence Planning Life cycle stage and family circumstances Values and attitudes Values fundamental beliefs about what is important in life Attitudes opinions and psychological differences between people that affect their decisions General economic conditions Inflation interest rates economic cycle employment global and political conditions Plan for death and incapacity Chapters 16 17 1 Inflation Inclination to Risk More Inclined Characteristic to Take Risk Less Inclined to Take Risk Male Gender Single Marital Status Young Age No Kids Family Type Wealthy Wealth Employment White Collar Income High Income Education College Grad Female Married Old Have Kids Poor Blue Collar Low Income High School Trends Over Time What is inflation and how is it measured Inflation Percentage change in the CPI from one period to another The Consumer Price Index CPI Measure of the price of a representative basket of household goods and services Separate indexes for urban and non urban for different areas of the country Basic Supply and Demand Principles The prices of goods and services are affected by supply and demand When there is a lot of demand for something lots of buyers relative to supply not as many sellers the price tends to rise When there is a lot of supply lots of sellers relative to demand not as many buyers competition will cause the price to fall Federal Reserve Bank The Fed How does the Fed do it Controls monetary policy for the U S by taking actions that cause the Fed Funds Rate to increase or decrease When the Fed wants to stimulate the economy it takes action to decrease interest rates When the Fed wants to slow the economy it takes action to increase interest rates When the Fed wants to make interest rates go down it increases the supply of money in the economy by buying Treasury bills More money flows into the economy Competition forces lenders to reduce their rates Individuals can get lower mortgage rates and companies can make more investments 2 How does the Fed do it When the Fed wants to make interest rates go up it decreases the supply of money in the economy by selling Treasury bills This causes there to be less funds available for borrowing Lenders can raise their rates Companies cut back on investments mortgage rates go up and people cut down on spending Making Effective Decisions Assumptions Should be based on sound reasoning taking risk into account Marginal reasoning Should consider the change that will occur from a given decision the additional benefit or cost Opportunity cost Every action has a cost Should consider the tradeoffs Sensitivity analysis 3